Equilibrium pricing of currency options under a discontinuous model in a two-country economy

Xing Yu () and Yang Xiaoping
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Xing Yu: School of Finance, Nanjing Audit University, Nanjing 211815, PR China
Yang Xiaoping: School of Science, Nanjing University of Science and Technology, Nanjing 210094, PR China

Studies in Nonlinear Dynamics & Econometrics, 2016, vol. 20, issue 2, 185-198

Abstract: (Bakshi, G., and Z. Chen. 1997. “Equilibrium Valuation of Foreign Exchange Claims.” Journal of Finance 52: 799–826) studied equilibrium valuation for foreign exchange claims in the setting of the two-country Lucas-type economy. In Bakshi and Chen (1997), they assumed the money supplies follow two-factor stochastic volatility processes. Based on their model, we add two independent Poisson-type jumps, respectively into the process of money supply in each country. By solving a partial integro-differential equation (PIDE) for currency options, we get closed-form solutions of call currency option prices. Our model is a generalization of Bakshi and Chen (1997), and can contain a class of stochastic-volatility jump-diffusion (SVJD) models as special cases.

Keywords: currency option; equilibrium pricing; partial integro-differential equation (search for similar items in EconPapers)
Date: 2016
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DOI: 10.1515/snde-2015-0001

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